Global cement 2014 outlook

New year, new challenges. As the cement industry looks into 2014, what will the New Year bring? By Yuri Serov, Morgan Stanley, UK.

Challenges and outlook for the global cement industry in 2014

The year 2013 was not meant to pan out this way. A year ago most market watchers were looking forward to a year when recovery would entrench itself across the board. Western Europe was the region on which everyone focussed. Sure, in 2012 it produced another large fall under the weight of a double-dipping economy, but that down-cycle was most certainly drawing to a close.

Elsewhere, performance seemed assured. North America clearly delivered a turning with a nine per cent jump in demand, which surely was to accelerate. India was expanding steadily, if not particularly spectacularly. Russia added more than 10 per cent to consumption for a third year in a row. With the exception of Vietnam, most other ASEAN countries were growing at a double-digit clip, while in Latin America it was only Argentina that seemed to be spoiling the picture.

But as 2013 moved along, expectations had to be progressively trimmed. In Western Europe, volume falls are indeed becoming shallower, but the negative momentum is persisting for longer. North America slowed, which surprised many observers. However, the biggest negative shock hit in the parts of the world usually viewed as bedrocks of cement demand – emerging markets.

Generally, Morgan Stanley’s economics team maintains a cautiously optimistic view on the current global economic cycle, which started after the Great Recession four years ago, initially led by China and emerging countries, and is now entering its second half under US and developed market leadership.However, they note that improved outlooks for developed economies are unlikely this time to mean better prospects in the emerging world. After the financial crisis, the global economy has become much more of a zero-sum game than before, where higher growth in advanced economies will not necessarily generate more demand for emerging markets but rather capture a larger share of global growth.

Morgan Stanley’s global economics team has highlighted for a while broken growth models and related structural challenges in many emerging market economies. The specific issues differ from market to market, but the underlying theme has been similar – misallocation of resources either towards excessive consumption (like in India or Brazil) or investments (like in China, Turkey and many Asian economies). A supporting factor for this resource misallocation has been very low interest rates.

Historically, before the financial crisis, low interest rates in many emerging markets were a result of excess savings due to high current account surpluses (mostly the difference between exports and imports, or national savings and investment), which in turn were a result of burgeoning demand in developed markets. The financial crisis went a long way in correcting the misbalances. Current account surpluses have been shrinking across the board (or deficits extending), thus drying up liquidity. They have been gradually replaced as a source of cheap money with loose monetary policies in developed markets, with the programmes of quantitative easing (QE) running in the US, Japan and the UK, until recently, being most important.

Then, last May, the US Federal Reserve suggested for the first time that because of a recovering economy, it would start in the foreseeable future tapering its current QE programme, seen to be the final one put in place. Market reaction was immediate and severe. Fund flows sharply changed direction from emerging markets towards the US. This led to an abrupt fall in currencies and a rise in interest rates.Figure 1 shows the rise in interest rates across five large important markets. Long-term (10-year) government bond yields offer a proxy for market rates. They all rose beginning in May, a story repeated to various degrees across emerging countries.

Figure 1: long-term government bond yields

As a consequence, the autumn round of economic updates led our economists to cut their GDP forecasts for most emerging countries. The biggest negative adjustments were in India, Brazil, Russia, Thailand, Turkey, Mexico and Ukraine.

Effect on cement consumption growth

For cement specifically, interest rates are of paramount importance as a driver of construction activity, especially in the formal sectors of an economy. Informal building, the share of which can be large, especially in less developed countries, is affected by borrowing rates to a much lesser degree, but slowing economic growth is having an effect there as well.

As a result, estimated cement consumption growth in the world excluding China (usually removed when describing a global picture given that it dwarfs all other markets, while following its own trends) was only about two per cent in 2013 (Table 1). The forecast for 2014 is for an increase of 3.5 per cent. Both 2013 and 2014 are set to deliver the slowest growth in the world (ex-China) of the past decade outside the crisis years of 2008-09.

Does all this suggest that the growth story in emerging markets is over? Not at all. Consumption per capita rates still remain low in most regions. Most emerging countries are still on the rising part of the cement consumption bell-curve, which suggests that consumption per capita tends to rise in early stages of economic development before tapering off when GDP per capita reaches advanced levels (Figure 2). However, the future path should now be more moderate (and presumably more sustainable).

At the same time, despite economic healing in developed markets, a strong bounce in cement demand in most regions is unlikely. Figure 3 shows the history of cement consumption per capita across developed world areas. It clearly illustrates that, if one ignores cyclical movements, the trends in cement consumption in the two more stable parts of the world – North America and Western Europe North (ie excluding Mediterranean countries) – have been flat to declining since the early 1970s. What drove cement consumption in developed markets in the last 40 years was two bubbles: first in Asia (primarily Japan) and then in the Mediterranean countries of Europe.

As can be clearly seen from Figure 3, consumption per capita rates across all developed regions are now converging into approximately the same range. This is likely to be a sustainable level for advanced economies, as proven over many years by North America and Western Europe North. Hence, significant structural moves in developed markets are highly unlikely in the future. Cycles will continue, as they always do, but the countries should be seen as currently in the process of settling at a sustainable range of cement consumption per capita.

What about the high growth rates being observed in North America, particularly the United States? In truth, this is just a cyclical recovery. As demonstrated in Figure 3, the correction in North America during the crisis clearly went too far. Hence, a return to trend over the coming five years or so should be expected. But consumption should stabilise beyond that.

Outlook for cement prices

From the perspective of cement companies, volumes are not the only, and arguably even not the main, issue that matters. The other key variable is cement selling prices.

The lower volumes that are now being forecast for 2013 and 2014 do not just reduce companies’ revenue projections. When not matched with a corresponding decrease in the amount of new production capacity being added, they lead to lower capacity utilisation, which in turn results in prices not being able to keep pace with inflation. This can happen even in a rising market, if the demand growth ends up lower than initial expectations.

The reason for this is that new capacity additions, which are a constant feature in emerging markets, would have been initiated on higher volume assumptions. When new capacity eventually enters the market, demand that is lower than the initial baseline (even if still sequentially growing) will not be able to absorb all of it. This leads to lower capacity utilisation. This in turn puts pressure on selling prices. They fail to keep pace with cost inflation. This results in lower EBITDA margins.

Analysis that has been conducted in various markets demonstrates that selling prices are tightly linked to capacity utilisation. Figure 4 shows Russia as an example. In this chart, prices are shown in real terms, excluding general cost inflation. It is notable that the effect comes with a year’s delay, ie, capacity utilisation changes in one year will be seen in cement price changes a year later.

Figure 4: cement prices vs capacity utilisation, Russia

The current demand forecasts coupled with the projections for the capacity addition pipeline suggest that global capacity utilisation continued to fall until 2013 from a peak in 2007. North America is really the only region where utilisation is improving. There are no increases in capacity utilisation for emerging markets (ex-China) until 2015. As a result, although global cement prices will rise, the increases will be below the rate of cost inflation. Negative real prices will persist until 2015.

Figure 5: global capacity utilisation rate

What to expect in 2014?

So, turning back to 2014, what should we expect for the coming year specifically? Our regional forecasts are shown in Table 1. Overall, although still subdued, 2014 should produce better growth than the previous year. The largest contributor to this improvement is the lower rate of contraction in Western Europe. In emerging markets a somewhat brighter picture is predicated on better developments in India and a return to growth in countries like Egypt, Mexico, Morocco and Vietnam. However, risks to this improving view are still plentiful.

Table 2: cement price change ex-inflation YoY (%)

2012

2013E

2014E

2015E

2016E

2017E

Western Europe

1.0

-1.3

-1.0

0.1

0.2

-

Eastern Europe

-1.0

-1.2

-0.2

-0.7

0.5

-

Former Soviet Union

8.2

-2.3

-1.1

-0.2

0.9

-

North America

0.9

3.0

1.5

2.2

1.7

0.9

Latin America

0.6

-2.7

-0.7

-0.3

0.1

-

MENA

-1.8

-0.4

-2.3

-0.7

0.4

0.0

Sub-Saharan Africa

-2.0

-3.9

-1.4

-1.5

-0.2

-

China

-18.5

-3.1

1.2

0.5

-0.5

-0.5

India

1.7

-11.1

0.1

2.0

2.4

-

North Asia

6.2

-0.7

-0.4

-0.2

-

-

South Asia

-2.3

-3.0

-1.2

-0.8

0.0

-0.1

Australia/Pacific

-1.3

-2.4

-1.5

-1.1

-0.5

-

-10.3

-3.0

0.4

0.3

0.0

-0.3

World (ex-China)

0.6

-2.9

-0.8

0.0

0.7

0.0

Source: industry and national sources, company data, Morgan Stanley Research estimates (E)

• In Western Europe the long down-cycle is drawing to a close. However, despite a return of general economic growth, new construction volumes should still show a fall under the weight of past over-building and continued government austerity. Of the major economies, only Germany and the United Kingdom are likely to expand.

• With the exception of Cyprus there should be growth in all countries across Eastern Europe. However, Turkey, the largest cement consumer in the region, is expected to experience a major slowdown due to rising interest rates.

• Former Soviet Union countries are set for a further reduced pace of expansion. The completion of the build-out of the Sochi Olympics should put the brakes on the trend in Russia, which is already affected by a sputtering economy.

• In North America, the United States is primed for a re-acceleration of growth. Residential recovery will continue albeit at a decreasing pace, but it will be joined by a recovery in non-residential buildings (which was behind a negative surprise in 2013) and infrastructure.

• Brazil, Latin America’s largest market, should continue with muted expansion, but there are downside risks after the World Cup preparation finishes. Mexico, on the other hand, should bounce from last year’s cyclical slump.

• There should be better trends in the MENA region, as Egypt and Morocco recover after drops. The United Arab Emirates is also starting to show clear signs of revival, which the awarding to it of Expo 2020 will further support in years ahead.

• Given its still very low levels of cement use, sub-Saharan Africa should be the fastest growing region globally in 2014 and beyond.

• In China, cement consumption growth is slowing and is expected to peak within the next five years. The economy has started on the path of transitioning from an investment led to consumption driven model, which should bring the many years of rapid expansion in construction to completion.

• After a disappointing 2013, the coming year should be better in India. The macro-economic situation will take time to heal, with inflation still running too high. However, a bumper harvest from good monsoon rains should support demand from informal house building, the most important segment in India.

• Structurally, there is no growth in North Asia (primarily Japan and South Korea), which is the likely outcome in 2014.

• In South Asia, a major slowdown is expected in Indonesia and Thailand. However, better trends in Malaysia, Vietnam and smaller countries should offset this and produce an improvement in the growth rate.

• In Australia, private infrastructure, linked to natural resource extraction, is to lead construction volumes down. This should be the only region besides Western Europe with falling volumes in 2014. The correction is expected to last for at least the next three years.

Article first published in International Cement Review, January 2014.

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